Saving, growth and the current account

Daan Steenkamp

ERSA / SASI Savings workshop August 2009

Agenda

• Link between saving, investment and the current account• Theoretical relationship between saving and growth• The case of a small open economy• Macro implications of low saving• Sustainability of the current account deficit• Implications for macro policy

Accounting identities

• In an open economy, domestic spending is the absorption of locally produced goods and services plus goods and services from overseas:

• Gross national product can also be expressed as the sum of expenditures by residents from national income

• Setting the above equal, the current account balance is the difference between domestic saving and investment (private and public):

• Current account balance is linked to net international capital flows:

• Re-arranging:

• Current account balance = Domestic investment - domestic saving • Foreign financing of domestic investment generate claims on domestic assets.

IBNCEMXGICGNP iv +++++= Pr -

TFRTSCGNP iv +++= Pr

)(+)(=++)(= GTISIBTRFNCEMXCA privpriv ----

NFATGIS privpriv Δ+)(+= -

CATGISNFA privpriv =)(+)(=Δ --

Saving & Growth Theory

• Exogenous growth models:– Saving supports higher investment and therefore a higher capital stock– Higher saving raises growth per worker only temporarily

• Endogenous growth models:- Higher saving raises per capita output and growth of per capita output

• Do savings alone drive growth? – Positive impact of saving has, however, been shown to be contingent on

complementary macroeconomic conditions and government policies that help channel savings into productive investment.

– E.g. financial sector development, macroeconomic stability, openness to trade, prudent fiscal policies, investment in education, microeconomic reforms that support efficient resource allocation.

• Can growth drive saving?– Life cycle models with liquidity constraints or endogenous models with habit

formation suggest that growth could impact saving.

Open economy setting

• If the economy is open and capital is mobile, foreign saving can be used to finance higher investment rate than domestic saving would allow.

• If the return on foreign capital after depreciation > cost of foreign borrowing- Foreign borrowing will raise the level of national income

• Availability of foreign capital can also lower domestic interest rates• Impact of inflows of foreign saving on domestic saving is ambiguous

- Lower interest rates reduce opportunity cost of current consumption, lower saving (substitution effect)

- Lower interest payments (borrowers) or income (lenders), can increase or decrease saving (income effect)

- Interest rate sensitivity of domestic saving an empirical question

6

High levels of domestic saving and investment are associated with high levels of economic growth

5

10

15

20

25

30

35

40

45

0

1

2

3

4

5

6

7

8

9

10GDP (RHS)Domestic Investment % GDPDomestic Savings %GDP

7

Saving shortfalls raises growth volatility

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

-4

-3

-2

-1

0

1

2

3

4GDP volatility

Balance on current account %GDP (RHS)

8

Impact of increased savings on the economy

• To increase domestic savings, domestic

consumption will have to decrease

• By substituting current consumption with

future consumption, investment can

increase, thereby increasing medium and

long run productivity

• The 5% level decrease in consumption

initially results in total saving increasing

by 20% which then allows investment to

increase by 15%

Decrease in level of consumption

-10-505

10152025303540

per

cent

ConsumptionTotal saving

Leads to investment increasing significantly

0

5

10

15

20

25

per

cent

Investment

9

Increased investment increases exports and GDP

Increase in competitiveness

0

0.5

1

1.5

2

2.5

3

Pe

r ce

nt

ExportsImports

• The increase in productivity promotes

exports, improving our

competitiveness, while imports are

driven by the increase in investment.

• It takes about 1 year for the impact of

increased savings and investment to

fully flow through to GDP

• The rebalancing of growth from

consumption to investment has a

lasting positive impact on GDP

Impact of increased savings on GDP

0

1

2

3

4

5

6

per

cen

t

GDPSaving as % of GDP

10

Inflows of foreign saving have helped raise domestic investment

10

15

20

25

30

35

40

45

Source: SARB

per c

ent o

f GDP

Gross saving GFCF

Domestic investment requires sustained foreign financing which is dependent on macroeconomic stability

Proportion of gross capital formation financed by foreign capital

-50

-40

-30

-20

-10

0

10

20

30

40

%

Source: SARB

Low domestic saving relative to investment manifests as a current account deficit

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: SARB

per

cent

of

GD

P

Saving-investment gap Current account balance

The current account deficit has been comfortably financed

-9

-6

-3

0

3

6

9

12

15

18

% o

f GDP

Unrecorded transactionsNet other investment flowsNet foreign direct investment flowsNet portfolio investment flowsTotal current account

*Quarter 1 annualisedSource: SARB

Capital inflows adding to stock of foreign liabilities

-200000

-150000

-100000

-50000

0

50000

100000

150000

200000

250000

300000

3500001

994

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

R m

illio

n

Net equity liabilities

Net FDI liabilities

Debt liabillities

Source: SARB

15

Relying on foreign savings implies growing claims on the income of domestic assets

-2

0

2

4

6

8

10

12

14

2002

2003

2004

2005

2006

2007

2008

per c

ent o

f GD

P

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

per c

ent o

f GD

P

Net capital flows as % of GDP

Dividend payments as % of GDP (RHS) -lagged two quarters

An increasing proportion of foreign liabilities are equity liabilities

0

10

20

30

40

50

60

70

80

90

100

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

%

Equity

Debt

Source: SARB

Foreign Portfolio Liabilities: Equity and Debt

17

Volatility is a greater problem if majority share of capital is short term capital

0

5

10

15

20

25

30

35

40

45

50

2000 2001 2002 2003 2004 2005 2006 2007

% to

tal i

nves

tmen

t

direct investment (long term capital)portfolio investment (short term capital)other investment

Cost of capital

Declining costs of domestic borrowing

-3

0

3

6

9

12

15

18

21

24

27

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

per c

ent

Nominal prime*

Real prime (CPI)**

Real prime (CPIX)***

Source: SARB, NT calculations* End of period** Metropolitan areas, 2000=100*** Metropolitan and other urban areas, 2000=100

Cost of capital

Declining costs of foreign borrowing (before crisis)

0

3

6

9

12

15

18

2000

2000

2001

2001

2002

2002

2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

per c

ent

0

100

200

300

400

500

600

700R157 yield

SA sovereign spread (EMBI) (RHS)

Sustainability of the current account

• In the short term, the availability of foreign capital will depend on maintaining investor confidence.

• This underscores the importance of sound macro management and political stability. • In the longer run, the efficiency with which saving is converted into investment is

particularly important for the sustainability of the current account deficit and ensuring we benefit from drawing on foreign saving.

• Servicing our foreign debt requires an increase in future exports or sufficiently high future real returns to domestic capital to service.

• Microeconomic reforms that address constraints to growth and enhance the economy’s international competitiveness and flexibility are crucial.

Conclusion

• By investing in resources, rather than consuming them, economies make a trade-off between present and future standards of living.

• Investment is funded through savings (both domestic and foreign).• Fixed investment allows for more sustainable economic growth and improves

international competitiveness.• In spite of low domestic saving, availability of foreign savings has supported higher

domestic investment in South Africa. • This has, however, seen the current account deficit widen and foreign liabilities rise. • Foreign saving must be used to expand our ability to export and save in future. • A higher rate of domestic saving would reduce our vulnerability to the vagaries of

investor sentiment. • It would help us develop a deeper and more liquid capital market, helping our

companies expand. • Higher saving would also give South Africans a greater stake in the gains from domestic

growth.